Buyback of Shares: Provisions and Evaluation | Equity Shares

Read this article to learn about buyback of shares. After reading this article you will learn about: 1. Salient Provisions Regarding the Buyback of Shares 2. Evaluation of Buyback Option.

Salient Provisions Regarding the Buyback:

Salient provisions regarding the buyback of shares are as follows:

(1) Buy back in a financial year shall not exceed 25 percent of the free reserves and equity of a company.

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(2) Buy back would be used only for restructuring of capital and not for treasury operations.

(3) Buy back of shares can be done out of the company’s free-reserves, share premium account or proceeds of any earlier issue specially made for buy back purpose.

(4) The post-buy debt-equity ratio will be at 2: 1.

(5) There will be a 24-month gap between two buy backs of the same type of security. However, there would be no bar on the issuance of other types of securities including debt, debentures and preference equity.

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(6) Companies desiring to buy-back shares will have to seek following approval from the Board of Directors.

(7) The buy-back process will have to be completed within 12 months from the date of passing the special resolution, authorized by the Article of Association of company.

(8) Companies, which have defaulted in repayment of deposits, redemption of debentures/preference shares and repayment to Financial Institutions will not be allowed the buyback option.

(9) A company seeking buyback will be permitted to do so after making full disclosure, of all facts, the need for the buyback, the class of shares to be bought back, the person from whom the buyback is to be effected, etc.

(10) ESOPs cannot be issued to promoters or directors holding 10 percent or more shares.

SEBI has also laid down the following guidelines regarding the buyback option:

(1) Companies are not permitted to buy-back their own shares through negotiated deals, spot transactions or private arrangements. They can, however, buyback shares through tender offers, proportionate purchases (refers of a rights issue), Dutch action (reverse of back buying) and stock market.

(2) Buy-back, on an exclusive basis, of shares issued under ESOPs to employees is not permitted.

(3) Companies buying back their own shares through stock exchanges shall be required to disclose their purchases daily. Negotiated purchases not recorded on exchanges will not be encouraged for buying back shares.

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(4) Promoters shall not be permitted to tender their shares if the company opts to buy back shares through the stock market route.

(5) Buyback would cover only equity shares and that all payment would have to be made in cash.

(6) A buyback offer once made cannot be withdrawn.

(7) The promoter would be required to declare up front the pre and post buy back holding in the company so as to leave no room for manipulation.

(8) The price at which share will be bought back will have to be determined by shareholders through a special resolution.

(9) An offer for buy back shall not remain for more than 30 days except in the case of purchases via brokers.

(10) Shares bought back will have to be extinguished within seven days of the purchase.

(11) The verification of shares received in buy back has to be completed within 15 days of the closure of offer and payments made within 7 days.

(12) The company will have to create a separate account to ensure payment to shareholders tendering shares. In the case of the stock market route, investors will get proceeds from the brokers and therefore, to ensure account is not necessary.

(13) The company should take steps to ensure that the insider trading regulations in respect of ESOPs are not contravened.

SEBI has placed the onus of a company complying with its regulations on the merchant bank. This is why association of a merchant banker in every offer has been made essential. The merchant banker will have to issue a due diligence certificate.

Evaluation of Buyback Option:

Buy backs enable a company management to increase its voting power in percentage terms at no cost to the management. The cost is paid from company funds. Another arrangement given in favour of buy-back is that it will raise share prices and thereby help to revive the capital market.

Buy-back of shares under ESOPs gives an opportunity to the employees to exit at a fair value. In many cases the liquidity in shares may not be adequate to permit sale of a large number of shares at a fair price.

Share buy backs lead to reduction in outstanding equity capital, resulting in a rise in future earning per share (El’s) of the company and hence creates higher value for the shareholders. A shining example of the benefits of share buy-back is Bajaj Auto Ltd. (BAL) which opted for a buy-back of Rs. 1.82 crore shares (15% of the issued capital) in October 2000 at a price of Rs. 400 per share, paying out more than Rs. 725 crore in cash to shareholders.

Interestingly, BAL chose to price its buy back price higher than Rs. 350 at which the stock was then quoting. The buyback proved highly beneficial for the Company, as when the profit started rising, the jump in EPS was substantial.

Likewise, Bilaspur Industries Ltd. (BILT) in a restricting exercise decided on only 26, 2007 to buy back 40% of its equity share capital after splitting each share with a face value of Rs. 10 into five shares of Rs. 2 each. Each shareholder was allowed to sell 2 out of every 5 split shares back to the Company at Rs. 25 each.

However, not all buy-backs enhance a firm’s value in the stock market. In any case, no marginal effect on the market can be expected from buybacks as they have many negative features too. For instance, with buying back of shares, the firm’s debt-equity ratio will rise, increasing risk exposure of the enterprise. Reduced liquidity and borrowing capacity will further increase the risk.

The main danger in allowing buy backs is that promoters and market operators will have additional tools in their armory for price manipulation which is already rampant in India. Allowing buyback can create violent price fluctuation even without actual buyback taking place. This is because buy back possibility can be used by market operators as the basis for floating rumors that such and such company is going to buy back its shares at such and such price. Market operators can make a killing, but there may be no actual buyback.

As a result of rampant manipulation, the Indian stock market has already been turned into a ‘healings market’, characterised by disorderly price behaviour, excess speculation, high volatility and recurrent market crisis. The SEBI’s role is like that of a ‘riot police’. It acts after the crisis.

Although SEBI has utterly failed in checking price manipulation, it is being argued by some people that misuse of buy back for price manipulation can be prevented by just requiring that the share bought back be extinguished.

Even a small publicity made offer to buy shares, combined with other manipulative maneuvers, can be used to produce a highly magnified effect on market price, as the promoters of Videocon International recently demonstrated by their offer of a 2 percent ‘Creeping acquisition’ at 3-4 times the normal price of the share.

Certain guidelines of the SEBI regarding buyback under ESOPs are not practicable. For instance, it is easy to advise the company to ensure that insider-trading regulations are not contravened but difficult to practice it. Sale by employees in the open market is susceptible to insider trading allegation.